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Why Offshore Drilling Stocks Are Sinking Again

The race to zero continues.

Born and raised in the Deep South of Georgia, Jason now calls Southern California home. A Fool since 2006, he began contributing to Fool.com in 2012. Trying to invest better? Like learning about companies with great (or really bad) stories? Jason can usually be found there, cutting through the noise and trying to get to the heart of the story.
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What happened

The offshore drilling industry continues to take an absolute beating. On May 13, shares that make up nearly the entire sector fell by double digits on a combination of bad news on the oil inventory front, and a speech from U.S. Federal Reserve chairman Jerome Powell that spooked the entire stock market.

As of 1:16 p.m. EDT, shares of Valaris PLC(NYSE:ESV), Noble Corp.(NYSE:NE), Borr Drilling(NYSE:BORR), and Transocean(NYSE:RIG) were all down between 9% and 15%. Shares of Seadrill(NYSE:SDRL) were also down 4% at this writing, having recovered a bit after trading down more than 8% earlier in the day.

Image source: Getty Images.

So what

Powell's speech played a big role in today's sell-off for the broader market that's compounded things for these oil drillers. In the speech, Powell highlighted the uncertain state of a U.S. economy that has fallen deeply -- and quickly -- into recession. In particular, Powell pointed out that it would likely require more drastic intervention by the government to soften the economic blow of what is essentially a forced recession, caused by steps to limit the spread of the deadly coronavirus that causes COVID-19.

To sum up the market's reaction, today's big sell-off has the SPDR S&P 500 ETF Trust(NYSEMKT:SPY) down 1.8% in the afternoon on fears that the expected economic recovery may not be as certain -- or as quick -- as many hoped.

In addition to the worrying economic news, both the U.S. Energy Information Administration and the American Petroleum Institute poured more oil on the market's rally. Today and yesterday, the two organizations reported weekly petroleum inventory data that showed the U.S. is still awash in a massive oversupply of oil. At the same time, global oil production continues to exceed demand, and oil stored in container ships, commercial on-land storage facilities, and in pipelines is at record levels.

Now what

The blunt and frightening truth is: We could see every single major offshore oil drilling company go bankrupt this year. We've already seen Diamond Offshore file for bankruptcy, and it's almost a certainty that more will follow in the near future.

Oil producers are slashing spending. Offshore oil is one of the most expensive resources to develop, and also the one that takes the longest to bring to market. In the current environment, that's a recipe for disaster for offshore oil stocks, considering that the industry never really recovered from the 2015-2016 oil crash, and had only started showing signs of life in the past 18 months.

At recent prices, most offshore drilling stocks trade for about $0.50 or less, with only Transocean, at $1.44 per share at recent prices, much over $1. If that doesn't tell you just how ugly things are offshore right now, I don't know what will. Over the rest of 2020, we may see the entire sector go through bankruptcy proceedings to reorganize, and get their balance sheets more in line with the cash-generating capabilities of their operating assets. Even Transocean and Seadrill, with more than $1 billion in cash on their balance sheets, are facing massive amounts of debt maturities in the next two years that they may not be able to refinance.

Investors in the offshore drilling sector have already lost nearly everything over the past few years. Now is not the time to fish offshore on the hopes of catching value. In a few months, I expect that lenders will be the only ones recouping much of anything, as the entire sector hits the "reset" button on their capital structures.